The Investment Risk of the Djakarta Plant - Case Study Example

Problem-Solving Paper Task Problem-Solving Paper Task One Considering the results of the calculations attached on the excel sheet, the Djakarta Plant is a more viable idea. The evaluation shows that the project has a more positive NPV compare to that of the domestic project. The project has a shorter payback period compared to the other and considering the IRR, the project will generate more revenue too. Following these results, the project that seeks to have the Djakarta plant is worth taking the investment risk on compared to the other project of Gladstone Plant. The NPV indicates that the project will generate more returns and within a shorter period compared to the Gladstone plant. Task Two The company stands risk with the business premium and the financial position. These risks all affect the discount rate applicable in valuing a business asset. The two discount rates as applicable to the case all work well in determining the actual value of the airlines to dispose off. Application of opportunity cost to select the appropriate discount rate could bare better results for the company. For this to prove possible there is need to consider both the two options and identify which one best describes the picture of the company and the true discount rate to use in the case. CFO’s Opinion According to the CFO, the airline is a separate entity to the businesses of the company. The company having operated as an independent arm of the major company would have it take full responsibility for the purchase of their own assets and the carriage of the risk in business terms. This means that the assets and liabilities that the airlines wing carries remain a responsibility of the airline. The CFO further argues that the debt was incurred to carry more of the equipment for the airlines and therefore the airlines should take full responsibility. Basing the cost of capital on the airline also helps relieve the other divisions of the business from paying for debts that they consumed little or none. The risk free rate, market risk premium and the tax rates all employ the considerations of the risks involved in business. CEO’s Opinion Considering the CEO’s option encompassing the market risks and the other financial risks that arise, it is fair to understand the risk that the business stands if it is to use this option. In calculating the risk, we consider the return on equity that the asset is expected to return if it is to be maintained. Using the Modigliani-Miller assumptions that relate to constant cash flows and a debt level that is also constant, the required return on equity is obtained using the formula below: RE= RA + (1-T) (RA-RD) (D/E) Where RE stands for return on equity, RA is return on assets, RD return required by debt holders, T represents corporate tax and D/E is the debt ratio. Calculating the return on debt on the other hand helps the company establish their position on the assets returns on the debt employed. The company can weigh the worth of the asset through this. Through this, the productivity of the asset in relation to the debt input is easy to identify. To calculate these, one considers the risk premiums that the business stands to face. These range from the business risk, financial risk and total corporate risk existent. The business risk originates from the operations of the firm and incorporating it into the decision to consider a discount rate to use would prove difficult. Based on the above stated two approaches, the approach of the CEO is a better approach since it considers the most relevant aspects within it. This method covers all aspects of risk that the company may stand including the advantages and disadvantages that follow. Considering the opportunity cost covered, the taking of the second option is at the expense of treating the debt in an equal manner for all divisions of the company. Task Three Free cash flow to equity refers to the measure used to determine the much from returns is applicable to the payment of shareholders that the company holds after the deductions that include all expenses, cash reinvested and repayments of debts. The calculation of this relates to the formula FCFE is equal to Net Income – Net Capital Expenditure – Change in Net Working Capital + New Debt- Debt Repayment FCFE= 480-500-50+0-0= -70 Considering the current dividend policy, the company issues $2 per share for 50 million shares outstanding. Reducing the company’s capital investment and increasing the return levels through investment in projects with a better IRR would result into better financial implications. Investing into project 5 that is Parramatta Commercial Precinct would have the FCFE change to: 540-100-50+0-0= 390. Paying dividends from this leaves the company with more returns as cash for the next financial year. Considering the projected normal dividend payment retained as per the organization’s policy, the cash balance is 290 and the highest for this project as indicated in the excel attachment. This means that the dividend policy sees this project generate more cash for the company. Changing the dividend policy to increase the shareholder’s pay by $1 per share will motivate the shareholders. This will increase the dividend payout and reduce the cash balance that the business retains at the end of the year. The retained cash is $240 million. Adding to the cash balance of $100 million, the projected cash balance will be $340 million. Task Four Employers have must make retirement contributions for their employees. One such retirement’s contribution platform adopted by most companies is the superannuation fund. This refers to a pension program of an organization created by the company in order to benefit its employees. Some sectors refer to it as a company pension plan. This is a special type of retirement fund, as funds deposited into a superannuation account will grow typically without any implications of tax until its retirement or withdrawal. As such, most of these pension program plans are usually either defined benefit or defined contribution plans. In selection of a superfund, employees can make suggestions to the management or their employers on the accounts they want their employers to pay their contributions into, as long as this is a complying fund structure. A complying fund is a super fund that receives concessional tax treatment because of its regulatory feature under the relevant super legislations and does not have a notice of non-compliance. There are five basic types of super funds available for employees to join and enjoy their benefits. However, each fund has its own basic qualifications thereby determining who has the eligibility to join the superfund and enjoy its benefits. The public sector funds are the most common and easily accessible super funds within the market. These funds are generally open to commonwealth, state and territory government employees. Corporate funds are generally open to people working for a particular employer or organization. As such, any employee who does not work in a particular organization and wants membership into the fund cannot access it. Industrial funds are also common funds accessible to almost everyone despite their employment backgrounds. However, one can join these funds if they work in a particular industry or under a particular industrial award and the employer signs up with the fund. Retail funds are also open to everyone as they operate under the management of various financial institutions. The last type of super funds is the Self Managed Super Funds (SMSFs). These funds work just like the other super funds but the responsibility of managing their operations rests solely with the trustee, who in most cases is the employee. Establishment and operation of a SMSF takes a major financial decision. This is because in this type of fund, one is both a member as well as a trustee. Therefore, the employee has control over, and responsibility for their fund’s investment decisions. Furthermore, the trustee has to manage the legal responsibilities of the fund. SMSFs receive tax concessions just as any other super funds and certain contributions made to the fund undergo taxation at a nominal rate of 15%, as is the case in other normal super funds. CEO’s Report The CEO of QVB investors has to evaluate the available investment options before making the right choice of a superfund in which to make contributions of his employees pension. This will enable the employees to make some good earnings from their employer’s contributions to their pensions going with the expected returns within the industry. The CEO has three main asset classes to contribute to in a super fund platform. The choice of these three assets depends on the profit margins of these assets, as well as the growth potential of the investment as evidenced over the three years period provided by the financial report. Generally, the CEO must select assets that guarantee a high return on investment so that his employees will have a higher volume of their retirement fund or pension scheme once it matures. The available assets for the CEO are banks, industrials, and resources. References Alvarez, F. & Fridson, M. (2011). Financial Statement Analysis: A Practitioners Guide. Hoboken, New Jersey: John Wiley & Sons. Arvasri. (2010). Managerial Economics and Financial Analysis. New Delhi: Tata Mcgraw-Hill Education. Drake, P. & Fabozzi, F. (2012). Analysis of Financial Statements. Hoboken, New Jersey: John Wiley & Sons. Hales, J. (2006). Accounting and Financial Analysis in the Hospitality Industry. London: Routledge. Helfert, E. (2002). Techniques of Financial Analysis: A Guide to Value Creation. New York: Mcgraw-Hill Higher Education. Herist, K., Rollins, B. & Perri, M. (2011). Financial Analysis in Pharmacy Practice. Florida: Pharmaceutical Press. Johnston, D. & Johnston, D. (2006). Introduction to Oil Company Financial Analysis. Boston: Pennwell Books. Mayes, T. & Shank, T. (2011). Financial Analysis with Microsoft Excel. Stamford, Connecticut: Cengage Learning. Shim, J. & Siegel, J. (2007). Handbook of Financial Analysis, Forecasting, and Modeling. Boca Raton: CCH. Vogel, H. (2010). Entertainment Industry Economics: A Guide for Financial Analysis. 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